Sensitivity to Market Risk by 2xuH469


									                             Sensitivity to Market Risk
Sample comment for 3 rating

Sensitivity to market risk is less than satisfactory. The bank is significantly exposed to
falling interest rates. The September 30, 2009, analysis projects that net income will
decrease by 27 percent if interest rates fall by 100 basis points. The bank is well outside
its policy limits on both net interest income and net income sensitivity, and it has been for
at least one year. Declining interest rates have significantly eroded the net interest
margin, which has trended downward from 3.35 percent in 2007, to 3.21 percent in
2008, and to 2.82 percent for the first nine months of 2009. Falling interest rates have
cut yields on floating-rate commercial loans and accelerated cash flows on mortgages,
mortgage-backed securities, and callable bonds. Virtually the entire investment portfolio
was prepaid or called in 2008. Proceeds were reinvested at lower rates, resulting in the
yield on investments falling from 5.63 percent for the nine months ending September 30,
2008, to 3.58 percent for the same period in 2009. The liabilities have not repriced
downward, given the large volumes of long-term, fixed-rate FHLB borrowings and 30-
month, fixed-rate certificates of deposit, which together represent 35 percent of total
liabilities. Management’s ability to reduce funding costs in response to further decreases
in interest rates may be limited because non-maturity core deposits are near their
effective floors.

The interest rate risk monitoring system was improved since the prior examination;
however, it still lacks an adequate independent review. Risk is measured by a Sendero-
based model using data from the general ledger system. Management should develop
assumptions for the sensitivity of non-maturity core deposits based on the bank’s
historical experience rather than standard national data.

Chief Financial Officer Brown indicated that the bank recently hired an outside
consultant to review the bank’s current measurement system and implement the
recommendations in this examination report. He further stated that the bank is
committed to reducing interest rate risk exposure by developing and implementing new
funding strategies. These new strategies will ease the re-pricing risk that has resulted
in the narrowed Net Interest Margin.

June 2009

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